Can you Start a Competing Business?

Posted by William J. Piercy on

Can you compete with your own company by starting a competing business? Some entrepreneurial mavens argue that competing with yourself is essential to innovation. But what are the legal consequences of doing so?  Consider Laverne and Shirley, who each own an equal share of a successful business. Can Shirley start a competing business with other partners?  It depends. What is Shirley’s role in the business?  Does she have a written contract with the company or with Laverne? The answers to these questions can make a big difference in determining Shirley’s right to compete.    

Role Within the Entity

If Shirley is merely a passive investor, she can probably compete with the business. But, if she holds a management role, she will generally be precluded from competing. With managerial and operational responsibility generally come fiduciary duties to act in the best interests of the business. If Shirley is also an employee, she may owe the business a duty of loyalty that would prevent her from simultaneously owning or working in a competing business, depending on the duties and responsibilities of her employment.  

Contractual Obligations

Often, written contracts specifically address to what extent members, managers, shareholders, officers, directors, and employees can participate in competing ventures.  Some agreements expressly forbid any competition, even among mere passive investors.  Other agreements expressly allow managers, officers, and directors to participate in a competitive endeavor, so long as it does not interfere with their managerial duties.  Reading and understanding contracts that speak to these issues is vital in determining whether it is kosher to compete. 

Don’t Use the Company’s Resources to Compete It.

Under no circumstance may Shirley use the resources of the business she shares with Laverne to compete with that same business.  Such resources would generally include capital, employees, data, or business processes for competitive purposes that do not benefit the business that owns that data.   

Imagine for a moment that Shirley is both an officer and an employee of the company and that her employment agreement as well as the company’s shareholder agreement expressly prohibits her from engaging in competing ventures.  What happens if she competes anyway?  Likely, Laverne will sue Shirley for breach of contract, breach of fiduciary duty, or usurpation of corporate opportunity.  But if instead, Shirley meets with experienced legal counsel, and carefully considers the implications of competing with her existing business, she may well avoid that unpleasantness.

If you have questions about your rights or those of your business partner to participate in a competing venture, please let me know if I can help.